Falling euro threatens both sides of Atlantic

The dramatic move by central banks of the major industrialized nations to shore up the falling euro is being driven by complex economic and political calculations - and poses new risks on both sides of the Atlantic.

While many analysts doubt the action taken on Friday will have much effect, the synchronized move by the US and other industrialized nations shows how serious the economic consequences could be if Europe's common currency continues to drop.

In Europe, officials are worried that a weak euro will stimulate inflation as imports become more expensive. The high price of crude oil is compounding the inflation threat.

For the US, major American multinational companies could find their overseas' earnings hit if the euro continues to fall, sending stock prices down. High stock valuations have bolstered consumer purchasing in recent years. A plunge in the stock market, it is feared, may dampen the economy right before the presidential election Nov. 7.

That, at least, is the apparent concern of Vice President Al Gore. Analysts say he was instrumental in getting the US to go along with other central banks Friday in buying up billions of dollars worth of euros in hopes of stabilizing the currency. "[Vice president Al] Gore got frightened," says Washington economic consultant Harald Malmgren.

Earlier this month, the European Central Bank intervened itself in the markets to drive up the euro and sought the help of the US - without success. Any such action was opposed by the Federal Reserve under Chairman Alan Greenspan and Treasury Secretary Lawrence Summers. They welcomed a strong dollar. But the Clinton administration changed its mind last week.

By Friday, the euro had slipped 28 percent against the US dollar since its peak shortly after its creation at the start of 1999. The baby currency was worth only 86 cents just before the coordinated intervention.

The European Central Bank, along with the US and Japan, explained their move as a result of "shared concern about the potential implications of recent movements in the euro exchange rate for the world economy." Britain and Canada also helped out.

The action is a high-risk move. Interventions in foreign-exchange markets by governments have a high failure rate. With perhaps a trillion dollars of currencies traded daily on these markets, even a multibillion intervention may not do the trick. Reports from Europe suggest $10 billion was used to bolster the euro on Friday.

Though significant, it was small compared with some past efforts. The Group of 7 industrialized nations spent far more in driving down and stabilizing the US dollar in the mid-1980s.

Market participants will be watching closely today to see if there is further joint intervention, or whether it was a one-shot action. There is considerable skepticism in London and New York that Friday's action will do the trick. One analyst talked of a euro worth a mere 80 cents. That would be embarrassing for the governments involved.

American officials have been telling their European counterparts that more economic reforms are needed before the US would give any help to the euro. Four hours after the intervention, Mr. Summers told a press conference in Washington that longstanding US policy calling for a strong dollar is unchanged.

"A strong dollar is in the national interest of the United States," Summers said.

That left foreign-exchange traders puzzled. If the euro strengthens, the dollar of necessity weakens. Traders are uncertain whether the central banks will step into the market again this week, should the euro fall.

Summer's statement "doesn't compute," says David DeRosa, an economist at the Yale School of Management in New Haven, Conn. A former foreign-exchange trader himself, Mr. DeRosa added, "If he thinks that is going to fly..., he is wrong."

Insiders in London say perhaps 60 percent of traders figure the euro will weaken again. Thus they will bet against it in their foreign-exchange positions. A minority in the market maintain the allied central bankers will support the euro further - thereby allowing a weaker dollar.

If they do, there's a danger the dollar will plunge further than Washington desires. Foreign investors in US stocks and bonds could start selling their massive American investments.

That would be bad news for Democrats, proud of the strength of the American currency. The sales would also depress bond and stock prices. It would make imports and European travel more expensive. Eventually, it would trim the huge US deficit international payments.

Views differ sharply on whether the major industrialized nations should be propping up the euro at all.

DeRosa, for one, regards it as nonsense that a weak euro would seriously damage the world economy. Intervention, as he sees it, was an unnecessary move to please the Europeans. He would prefer that the price of the euro be left to demand and supply forces on foreign-exchange markets.

Contrariwise, Robert Solomon, a guest scholar at the Brookings Institution in Washington, says "it makes sense for the US to cooperate with Europe" and help out the euro.

To DeRosa, the explanation for the decline in the euro to a record low last week was largely the disarray in European politics. The ECB wants a strong euro. Top IMF officials also hint that the euro should be supported. Managing Director Hans Koehler calls it "heavily undervalued."

But earlier this month German Chancellor Gerhard Schrder cheered the weak euro as good for Europe's exporters.

"These guys haven't got their act together," says DeRosa.

(c) Copyright 2000. The Christian Science Publishing Society